Will Canada hike interest rates in June? The answer may be in Australia…

We’ve been watching the gradual recovery of the economy in Canada with great interest over the last 6-9 months and as we near the mid point of 2010 signs relating to spending, productivity and employment all keep ticking (slowly but surely) upwards. Speculation as to whether this will subsequently translate to an increase in bank interest rates has been growing in both rumour frequency and indeed likelihood has mirrored the economic gains as the country moves away from recession. June and July are seen as the most likely months that the Royal Bank of Canada will increase the base rates which would make Canada the first country in the G7 to hike rates. Interesting there is a developed economy outside the G7 that are a few steps ahead in terms of lending rates which is drawing a model for comparison among economic analysts. Australia’s Reserve Bank began raising rates last Autumn and although the parallels aren’t pure (the Australian economy is far more closely linked to China and thus didn’t fall into the deep recession suffered through Europe

Ayers Rock, a symbol of Australian economic solidity?

and North America) the changes in Australia may provide a good model for Canada to observe.

Whereas Australia follows the economic highs and lows of China, Canada naturally is more tied in to the United States. Unlike the US the recessionary statistics appear more removed on the Canadian landscape setting up the recipe for a hike in rates. This weeks announcement of a further unemployment spike in the States coupled with the continued chaos and instability in the European markets clearly shows that Canada would be the only G7 nation to even consider interest rate changes in the near future. So with Australia as the guinea pig let’s look at the path they have followed.

Amongst all developed economies the first to begin raising rates was The Reserve Bank of Australia who did so initially in October of 2009. Economics forecaster ‘Action Economics’ predicts that Canada is positioned to mirror what the Reserve Bank of Australia have accomplished over the last 8 months.  Ryan Brecht, an analyst with Action Economics:

“Considerable differences between the Canadian and Australian growth and policy backdrops have kept the Bank of Canada on hold while the RBA has been moving rates higher. Yet the Canadian economy has improved to the point that currently extremely accommodative policy is no longer appropriate, leaving the Bank of Canada in a somewhat similar position to where the RBA was late last year.”

In October the RBA initially raised its key policy rate by 25 basis points last October, to 3.25% which was quickly followed by additional hikes in both November and December. Since the turn of the year further increases in 25 point stages have seen the basis rate now stand at 4.5%, an increase of 125 points in just over seven months. Experts predict the Bank of Canada rate to reach 1.5% by the end of the year which would require a matching 125 point increase over the coming seven months. Longer term speculation sees base rates being as high as 2.5% within 12 months. Australia’s growth hasn’t displayed significant slowing since the hikes began and lending has exceeded 2008 rates. The next two weeks in European economics may determine if the June hikes are delayed due to a severe case of nerves or if the RBC is ready to follow the path taken by Australia.

Stay tuned – I predict a modest hike in July.